Tuesday, May 31, 2011

Till early this month,
there was an expectation among the various stakeholders that the Reserve Bank
of India (RBI) would strike a balance on the contradictory responses to various
recommendations put forth by its sub-committee — the Malegam panel — on a policy
for microfinance institutions (MFIs).

But the RBI's
announcement of a MFI policy on May 3, broadly on the basis of the Malegam
panel's views, throws up more questions than answers on the health of the
microfinance model.

An analysis of the key
points of the RBI's policy suggests that the apex bank may be batting more for
the big MFIs, leaving aside the smaller players and, more importantly, the
poor.

To begin with, the
fixing of the interest margin and interest rate cap at 12 per cent and 26 per
cent respectively would still leave more profit margins for the bigger MFIs in
a sector linked with financial inclusion and economic empowerment of the poor.

According to industry
estimates, the average cost of funds for MFIs varies between 12 per cent and 14
per cent, while operational expenses for the big MFIs are 6-7 per cent. So,
there is actually no strong case for the RBI to fix the interest rate cap at a
liberal 26 per cent, against the 24 per cent cap suggested by the Malegam
Panel.

Further, the RBI also
seems to have turned a blind eye to the fact that, over a period of time, the
incremental cost of operations would be less for major MFIs, which have a
presence in a large number of States. They can also take advantage of core
microfinance operations for other businesses such as sale of insurance, mobile
handsets, and so on.

For instance, SKS
Microfinance, which has announced plans to enter into lending against gold
ornaments to tide over the microfinance crisis in Andhra Pradesh, will
obviously use the same field force used for distributing micro loans, with
little incremental cost but with augmented income.

The business models
could still be viable for big MFIs, even if the interest is capped at around 20
per cent. The RBI could well have gone for a two-tiered model for deciding the
caps on interest margins and interest rates, taking into account the variations
in the cost of operations across major and smaller NBFC-MFIs.

If the RBI really wants
to protect the entire microfinance sector, it should also take into account the
situation of medium and small MFIs.

PROBLEMS IGNORED

It also appears that the
banking regulator is rather silent on some of the serious issues that came to
light in Andhra Pradesh over the last year.

The root-cause of the
MFI crisis in that State was the over-indebtedness of the poor, driven by
multiple lending. However, as against the stringent norms in the AP MFI Act on
multiple lending, it has been said in the policy that an indebtedness of up to Rs
50,000 could be allowed and a single member could take loans from two MFIs.

This is worrisome, as
the annual income of poor (going by the data of the AP Government) is below Rs
36,000 per annum.

If one could get loans
up to Rs 50,000, the maximum indebtedness, there can be multiple loans of
different combination for any MFI client. This means that the poor could be
constantly in a debt trap from which they cannot escape because their
indebtedness exceeds their annual income.

Under these
circumstances, it may come as no surprise if a similar situation to the MFI
crisis in Andhra Pradesh crops up in some other States, following the
saturation of their markets.

SELF-REGULATION

The need to ensure a
proper implementing agency has also been ignored in the policy. The question
still remains: While on-paper regulation is done by the RBI, who is responsible
for on-field regulation of MFI activities?

A gamut of operations —
from ensuring transparency in interest rates, maintenance of interest caps,
harassment-free collection and disbursal of loans, to name a few — have to be
monitored very carefully.

By ignoring a reasonable
contention of the Andhra Pradesh Government, that the lack of an enforcement
mechanism is a serious problem, the MFI policy went along with the Malegam
panel's suggestion that MFIs should be self- regulatory organisations.

Even for lending under
the priority sector category, banks may have no choice other than to go by the
interest margin/ interest rate submitted by the MFIs!

CLARITY

Given the seriousness of
the issue, the RBI should have also made a reference to the AP MFI Act in its
policy. The outward impression in the industry is that, along with other
recommendations, the RBI had also accepted the Malegam view that there would be
no need for the AP MFI Act if all of the panel's recommendations were accepted.
But the fact remains that the RBI is part of the Government. It cannot be
silent on an existing Act that totally contradicts the much-awaited policy on
micro-finance institutions.

As the Andhra Pradesh
Government is adamant about continuing with its Act, it remains to be seen how
things will unfold.

There was an interesting article that
appeared in the media entitled "Sequoia's Roller Coaster Ride with SKS:
The Gains & The Losses"

The
article claims that the notional loss of Sequoia in SKS Micro-finance was a
whopping Rs 1,199 crore or $268 million. The article however confirms that the
total investment by Sequoia was only $ 48.5 million in two tranches. Obvious
that something does not add up - a $268 million notional loss on an investment
of $ 48.5 million!

The
reality is that Sequoia had invested through two funds SCI II Llc and SCIGI I
with average cost of purchase pegged at Rs 61.18 and Rs 137.53 per share,
respectively. SCI II was a part of the group of shareholders who together
offered to sell a part of their holding in the public issue that was priced at
Rs 985 per share.

This part sale of their stake enables
them to recoup not only their total investment of $ 48.5 million but also
booked a small tidy profit. Their current cost per share is zero and the
historic low of SKS script at Rs 255 and it current price - Rs 342. So where's
the notional loss?

The article clarifies - "Notional
loss is computed assuming it had sold the shares at the peak of the
market as compared to current value."

Oh really??

Here's the spin which the Venture
Capitalist industry resorts to for attempting to generating public and
government sympathy for bailout of the sector. RA

Sequoia's Roller Coaster Ride with SKS: The Gains
& the Losses

Sequoia Capital India was the first venture capital
firm to spot microfinance as a sector that a VC can invest in India. In 2007,
Sequoia participated in a $11.5 million round in SKS when the other PE firms
were yet to spot the company. In 2008, it participated in another round of
investment of $37 million. But the big PE firms joined the party only in late
2008 when SKS raised $75 million from a group of PE firms like Sandstone
Capital at a much higher valuation.

In July last year, the company went in for a dream
IPO to raise Rs 1654 crore, which was subscribed about 14 times. The company's
shares, which got listed at Rs 985, rose to Rs 1490 on September 28, 2010. So
small wonder, it was a multi-bagger, trophy investment for Sequoia.

Cut to the present. The shares hit Rs 262, the
52-week low of the stock, although it bounced back to Rs 297.85 at the close on
Bombay Stock Exchange. Over the last few months, it has been a terrible time
for the microfinance sector in general and for SKS Microfinance specially.
Sequoia, which owns about 14 per cent stake in the company, has been considered
a promoter at the IPO, and has a three year lock-in. So the private equity fund
has been suffering all the brunt on the stock as it has no freedom to exit at
will. Where does that take Sequoia's holdings in SKS?

THE GAINS

To be fair, Sequoia made sure it didn’t lose all of
the gains it made as it part exited during the public issue of the SKS. It sold
part of its shares held by one of the two funds through which it invested over
three years ago with mouth-watering returns of over 16x.

Sequoia had invested through two funds SCI II Llc
and SCIGI I with average cost of purchase pegged at Rs 61.18 and Rs 137.53 per
share, respectively. SCI II was a part of the group of shareholders who
together offered to sell a part of their holding in the public issue that was
priced at Rs 985 per share.

The value of remaining shares representing 13.9 per
cent stake held by these two entities rose significantly when the share price
of SKS Microfinance hit its all time high of Rs 1,490 last September, just
weeks after its debut on the stock exchanges.

The value of shares held under SCI II Llc rose to
Rs 760 crore (~ $170 million) as against cost of acquisition of Rs 31.5 crore
(~$7 million) or 24 times in less than four years. The portfolio value of SCIGI
I rose to Rs 738 crore(~$165 million) from investment of Rs 68 crore(~ $15.2
million) or almost 11 times. But the shares have a mandatory lock-in that
restricts Sequoia from encashing any more of it soon enough.

THE
(NOTIONAL) LOSSES

While the company managed to steer through various
issues at the time of the IPO and pretty much had a similar performance post
listing as its Mexican peer Banco Compartamos, the firm was hit by a spate of
bad news including adverse regulatory changes in its most important local
market in India, the state of Andhra Pradesh.

This was visible in the latest quarter result of
SKS Microfinance. It posted a loss of Rs 69.7 crore in the fourth quarter ended
March 31, 2011 compared to a net profit of Rs 62.9 crore during the same period
previous year, as the company went through poor repayment rates and also faced
a new policy regime in Andhra Pradesh. The company's revenue also fell to Rs
193.8 crore from Rs. 304.5 crore in the same period.

Jittery investors have dumped the firm’s shares
that hit a new low on Tuesday quoting at Rs 262 before bouncing back to make up
for some of the loss and closed at Rs 297.85 a share at BSE. Even at this price
Sequoia is sitting on a multi-bagger with SCI II Llc on unrealised gains of
4.8x and SCIGI I with notional gain of 110 per cent.

The value of shares held by the two funds is Rs 152
crore and Rs 147 crore respectively. In effect Sequoia has lost Rs 1,199 crore
or $268 million assuming it had sold the shares at the peak of the market as
compared to current value. The venture capital firm could well make up for this
notional loss in the future, but for now it would be hoping, along with other
investors who bet on the microfinance lender at the public offer, to at least
get back to the price at which it sold part of the shares in the public issue,
soon.

An initial public offer by India's SKS Microfinance
sparked a debate on the ethics of profiting from the poor. The phenomenal
year-to-year growth of MFI prior to the Andhra crisis was fuelled by new
sources like private equity (PE), the capital market and debt instruments.

Private equity has helped push valuations to about
5.9 times book value, or nearly three times the global average. These PEs want
maximum returns within the shortest exit and the resultant was the kind of
excesses seen in Andhra Pradesh that led to borrower suicides and provoked a
backlash against the the whole industry. With PE investment in MFIs, it is the
PEs who control the company and who are the legal promoters of the company
though their PR continue the facade of a social business.

Within this context, this blog had been advocating
that SKS be treated as a proxy for the whole for-profit microfinance industry
and that the script be hammered so that these PEs be taught a lesson of their
lives. The only way they can do so is by suffering huge losses and never again
enter the micro-finance in the country in order to earn mega-profits by
exploiting our poor. The Andhra Pradesh Microfinance Act 2010 and the new
(Malegam) RBI regulations have significantly curbed the profitability of
microfinance institutions. The impact on SKS Earnings Per Share (EPS) is
plotted in the graph.

From a high of Rs 1,490, the SKS share touched a
low of Rs 255 in the second week of May. Huge volumes prior announcement of Q4
results led the stock exchanges to investigate the script for insider trading
violations.

Consequently the share was shifted from the rolling segment
(series: EQ) to trade for trade segment (series: BE) with a price band of 5%.
Bears caught by this step had to compulsorily square-off and the share rallied
to Rs 343 close yesterday.

Among PE investors entrapped in SKS are George
Soros firm, Quantum; Sequoia, Treeline etc. The Business Standard article
is republished to give an idea how hard PE investors are hit. RA

Macro losses for PEs in SKS Microfinance

The dream that turned sour for many a retail
investor long before has now begun to hurt the smarter ones, too. Early birds
who had bought chunks of SKS Microfinance Ltd before the Initial Public Offer
(IPO), at what for a while looked like throw-away prices, are staring at
losses.

A set of private equity investors have seen their
investment dip below cost price as the SKS stock dived below Rs 300 yesterday.
After dipping to an all-time low of Rs 255 on Tuesday, SKS recovered to close
at Rs 298.

SKS allotted shares to the public at Rs 985 in its IPO. The shares subsequently
hit a high of Rs 1,490 in September 2010. On April 26, the stock dipped below
Rs 500 on concerns over results. Even after this, most institutional investors
were sitting pretty with gains of over 30 per cent. But last week’s crash after
the company reported operating losses has caught many of them off-guard.

Two other investors, who bought immediately before
the IPO at much higher prices are already deep in losses. George Soros-owned
Quantum (M) Ltd and Tree Line Asia Master Fund had bought shares through
secondary transactions at Rs 636 a share. As of March 31, Tree line and Quantum
held 2.06 per cent and 2.37 per cent, respectively.

Saurabh Agarwal, director, Kennis Group, an
advisory for PE funds, said the funds will continue to hold, as the long-term
prospects are good. “Our internal
estimates suggest a further downside of 20 per cent. But once the regulatory
issues are sorted out, the stock will do well, as the permanent structures for
the business are already in place,”Agarwal said.

SKS had placed at least 15 million shares with a
second set of PE investors at a substantial premium of 30 times the face value
between March 2009 and March 2010. Sandstone Investment Partners, the single
largest investor in SKS, with 11.5 per cent stake, bought 8.3 million shares
for Rs 250 crore in the company in 2009. Kismet Capital LLC, ICP Holdings and
Bajaj Allianz Life Insurance are the other investors who took the stock at Rs
300 a share and are staring at losses. As of March 31, these investors together
held a little over 20 per cent in the company.

According to Mukesh Jain, head of private equity,
Equirus Capital, the investors have to take heart from the fact that they have
the advantage of selling the stake in the open market, as the portfolio is a
listed one. He said, “The cloud
still over the microfinance space due to the regulatory issues will also
reflect on the shares in the future. The money-making process is over and the
business model will no longer work as it did earlier.”The
dispute between the CEO and the promoters made things worse, he added.

Two funds, Catamaran 1A and Catamaran 1B, owned by
Infosys’ chairman N R Narayana Murthy, bought 938,000 shares for Rs 28 crore in
January 2010. This investment also went into the red on Monday.

According to the IPO documents filed with SEBI, Catamaran shall be subject to a
lock-in for a period of two years, but not if the market value of the equity
shares as calculated on the basis of average closing prices in a calendar week
goes below Rs 400. Breaching the lock-in has become a distinct possibility,
after the share prices dipped much below Rs 400 on Friday. In the past two
sessions, the shares have been trading well below Rs 300.